Thursday, September 14, 2017

Piketty, price markups, and Houston floods

There are two ways to critique something which questions strongly held conventional wisdom. The honourable way is to question the core of the argument, and a less honourable way is to detract attention from the core issue by picking holes on incidentals.

Consider three examples - Thomas Piketty's book highlighting the issue of rising incomes at the top of the ladder and widening inequality, a recent paper on rising markups in US businesses, and the Houston floods and the debate on zoning regulations in urban areas.

Take Piketty. Never mind that the primary takeaway from the book was the fact that inequality is increasing alarmingly across the world, the right-wing critique of the book was focused on picking holes at Piketty's argument that the returns to capital was higher than economic growth, thereby increasing the incomes of the rich and widening inequality. No, they argued, capital, especially the modern information technology based ones, depreciates fast enough to offset any high returns. Or, that among all returns to capital, it is increases in property prices that forms the vast majority of wealth creation.

Sure, there are some policy implications based on what are drivers of widening inequality, but is it a necessity for taking action on the first order issue that incomes at the top of the ladder are rocketing up even as those of the overwhelming majority are stagnating or declining?

As to the debate about whether r > g, the recent work of Alan Taylor, Oscar Jorda, and Co, on the returns to property, equity, bond, and government bills for 16 countries for the 1870-2015 period is only a confirmation of Piketty's argument. I have not seen too many blogposts in Marginal Revolution on this or their extended work!

In 1980, average markups start to rise from 18% above marginal cost to 67% now. There is no strong pattern across industries, though markups tend to be higher, across all sectors of the economy, in smaller firms and most of the increase is due to an increase within industry. We do see a notable change in the distribution of markups with the increase exclusively due to a sharp increase in high markup firms.

Tyler Cowen highlights his main takeaway - "In 1980, average markups start to rise from 18% above marginal cost to 67% now". And his response is grudging,

That sounds like big news, and probably it is.

He then goes on to conflate the fundamental issue of rising markups, and whether it is leading to rising profits and is the result of business concentration. He detracts attention from a first order problem by quibbling at flaws in data sources, arguing about monopolistic competition, and so on. What is the meaning of being disingenuous? Heck, monopoly profits or not, markups are markups, and they are happening!

As Noah Smith nicely summarises the growing pile of evidence - business concentration has been increasing, is correlated with declining labour's share in national income, executive salaries have gone up with deregulation, profits have risen substantially, there has been a slackening of anti-trust enforcement, prices go up while productivity does not after mergers, business investment declines has been associated with market power, and so on. Isn't all this adequate to connect the dots? Do we need to get exact evidence? In any case, is real world policy-making so exact a science that it requires information on causal channels with great precision?

Finally, consider the case of the recent floods in Houston and the loss of lives and damage caused, especially among those living in areas vulnerable to flooding. The city has long been the poster child for deregulated zoning regulations, reflected in its affordable housing, and contrasted with the zoning intensive San Francisco's exorbitant housing prices.

Forget Houston and zoning laws. Take any large Indian (or developing country) city beside a river. Encroachments on river banks and liberal building permissions in areas vulnerable to floods are commonplace. Flooding is an annual feature, with some deaths, houses washed away, and huge damages. In fact, large parts of Indian cities, with either poor or no enforcement, are the closest anywhere in the world to free market in housing development.

Instead of confining the debate to the issue of regulating construction on areas prone to flooding, the ideologues have been waging war on whether construction is responsible for flooding or not. While the left have blamed climate change and deregulation, the right has used the opportunity to blame everything from historical reality of Houston's flood pronenesss to subsidies on flood insurance. Since the ideological fort is under attack, the defenders have to mount their defence. In the din, the real issue of regulating (and it is not incentives that work here) housing on flood plains and, more importantly, promoting vertical development in the remaining areas has been lost. An opportunity to promote zoning regulations that work in this direction may have been lost.

In all the three cases, attention from the central issues - widening inequality, markups and business concentration, and unfettered construction in flood plains - have been scattered by splitting hairs on important, but secondary concerns.

In all these cases the narrative, as I see it, is this. Central tenets of ideological beliefs that have shaped both your life and career for atleast over 30 years are now being threatened. So you push back aggressively, even if it means stretching the boundaries of everything we call truth and decency. Everyone faces it once in a while, but ideologically prone individuals are the most vulnerable and possibly the worst offenders. It is as much true of the right as it is true of the left!